Risky Business: The Credit Crisis and Failure (Part III)

Collection and
effective analysis of financial market data may help prevent future
crises.The high human costs of market
crises, which may significantly affect those least well positioned to bear such
costs,[1]
make prevention of future crises a high priority.This is particularly true in light of the
pervasive financial market networks that characterize contemporary financial
markets.Further, through their
influence on financial variables such as interest rates and currency prices,
financial market networks reach deep into the homes and pocketbooks of a
significant portion of the world’s population.[2]The fallout from the subprime mortgage market collapse thus illustrates
fundamental ways in which financial market participants and the broader global
community are linked.

A. Costs of Ineffective Regulation

Individuals and
businesses bear costs in connection with regulatory and industry failures that
lead to market crisis.First, although
federal financial regulators "are largely self-supporting through fee
collections, assessments, or other funding sources,"[3]
individuals in their roles as consumers, taxpayers, workers, and investors pay the
costs for ineffective yet costly U.S. regulatory frameworks,[4]
including significant levels of business financing of regulation.[5]Second, although the costs of U.S. bailouts
are projected to be significantly less than the estimated $700 billion authorized
under the Troubled Asset Relief Program (TARP),[6]
taxpayers bear much of the cost of financial industry bailouts.[7]Third, taxpayers may suffer significant deleterious
consequences from the impact of the credit crisis on the real economy, which is
suggested by a broad range of economic data, such as unemployment and mortgage
foreclosure statistics, personal bankruptcies, and more restricted access to
credit.[8]Although the costs for financial market players have been high,
financial institutions’ losses have been subsidized by the U.S. government, and
ultimately borne to some extent by U.S. taxpayers.[9]Losses and costs from the credit crisis,
including credit losses, U.S. stock market losses, lost production and costs
associated with declining gross domestic product, have likely reached the
trillions.[10]

Given the enormous
costs imposed by the credit crisis, regulatory reform efforts need strengthening,
and reformers must fundamentally rethink the U.S. regulatory architecture.If the credit crisis does not lead to a
fundamental redesign of U.S. financial market regulation, it is not clear what
level of financial market catastrophe would be required to do so.With the exception of the Treasury Blueprint
optimal regulatory structure, none of the existing reform proposals come close
to fundamental redesign, which is troubling given the profound costs imposed by
the credit crisis and ineffective yet costly U.S. regulatory frameworks.Further, ineffective regulation is doubly
costly, because it may lull market participants, including investors, consumers,
and professional market actors into thinking that the government is actually
monitoring risk.

In the absence of
fundamental regulatory redesign, other useful actions might help better align
internal industry and regulatory incentives, such as intensifying penalties for
behaviors that create systemic risk, creating broader mechanisms for financial literacy
and education about risk at all levels of activity, and developing better risk
disclosure practices for market participants.

1. Meaningful
Penalties:Sliding Scale Incentive
Regulation

In addition to
ensuring that private market discipline rests on incentives that encourage
market participants to properly price risk, regulatory penalties should be
reconsidered in light of existing incentives.Auction Rate Securities (ARS) markets illustrate the impact of
incentives for financial market participants.ARS, which were first issued in 1984, are "long-term, variable-rate
instruments that have their interest rates reset at periodic and frequent
auctions.[11]The ARS market, which collapsed in February
2008, seemingly offered benefits to both issuers and investors.[12]ARS enabled issuers to vary their credit
spread over time by issuing long-term variable-rate debt without establishing
either a fixed interest rate or a variable benchmark and credit spread for the
life of the instrument at the time of issuance, as would be the case with traditional
fixed-rate or variable-rate instruments.[13]ARS were the subject of a 2006 SEC settlement
in which firms settled for $13 million, without admitting or denying SEC
charges.[14]This settlement is negligible when compared
to the amount of money that banks made from underwriting and managing ARS
auctions.Given the revenue flows from
the $330 billion that the ARS market reached before its collapse,[15]
and banks’ earnings of 1% for underwriting fees and twenty-five basis points
for each auction,[16] it is likely that banks gained far
in excess of the $13 million SEC settlement.For example, if the $330 billion in sales occurred in a single year,
with auctions of all outstanding ARS taking place monthly, bank revenues from
ARS underwriting fees in that year alone could exceed $3 billion.[17]

Given the monetary
incentives that existed in the ARS market, the 2006 settlement likely
constituted a minor slap on the wrist.The ARS settlement occurred during a time of declining penalty
collections by the SEC.[18]In contrast, sliding scale penalties
might provide a better mechanism for aligning incentives in some
instances.Sliding scale regulation has
been applied in the context of regulated industries such as telecommunications.[19]In the financial market context, sliding
scale penalties could be conceptualized as forced profit or revenue-sharing,
with payments into a fund established by regulators for certain first or
continuing regulatory violations.Assuming that the amount of the profit or revenue-sharing could be set
at an appropriate level, the prospect of such profit or revenue penalties would
likely facilitate internal firm risk management and shareholder monitoring to
avoid the penalties.In the ARS case, even
a penalty of as low as 10% of profits accrued for using the practices that led
to the SEC charges, or some percentage of firm profits during the periods in which
violations occurred, might have had a greater impact on future behavior.Recognition of the importance of meaningful
penalties was a factor in Judge Rakoff’s 2009 rejection of an SEC settlement
with Bank of America in relation to its acquisition of Merrill Lynch, which
reflects judicial concern about the nature, fairness, and amount of SEC
settlements.[20]Judge Rakoff described the proposed
settlement as "neither fair, nor reasonable, nor adequate" and noted that the
$33 million settlement was "a trivial penalty for a false statement that
materially infected a multi-billion dollar merger."[21]

2. Risk
Education and Financial Literacy

The credit crisis also
demonstrates a significant need for better financial education with respect to
risk, both for sophisticated market participants and regulators who need a more
comprehensive understanding of complex financial products, trading strategies,
and networks.Financial market
regulation that is based on an assumption of private market discipline
implicitly assumes that market participants have sufficient knowledge and
education to enable them to effectuate the discipline that is part of the
foundation on which market regulation rests.Although education can be a blunt tool, a pervasive lack of knowledge by
multiple parties was no doubt a factor in the crisis.For example, the ARS market was developed by
broker-dealers who were willfully ignorant about the products they sold.Interviews by Massachusetts officials of ARS
financial advisors revealed knowledge based only on conversations with other
advisors and mere anecdotal understanding of the products they were selling,
much of which was incorrect.[22]In many instances, ARS customers, including
sophisticated purchasers such as Pulitzer Prize-winning financial writer James
Stewart, lacked knowledge about the risks of what they were buying.[23]

In addition to better
professional education for market participants and regulators, greater
consideration should be given to ways to make retail investor education more
comprehensive and interactive.A
televised public service announcement series that focuses on investment and
financial market basics might assist retail investors in understanding
financial market products and investment best practices.Further, current methods for determining
retail investor qualifications may also be inadequate. In addition to the financial thresholds that
exist for individual investors under Regulation D,[24]
greater consideration should be given to having standardized investor tests as
a key aspect of private market discipline.True assessment of investor qualifications should go beyond the
check-the-box approach of some investor qualification questionnaires.For example, this could involve developing
interactive investor knowledge tests (IKTs), which could be geared to the
specific nature of varied investment opportunities.The purpose of such tests would not be to
require a particular score from a prospective investor alone or together with
the investor’s representative, but to help ensure that potential investors and
financial service providers are forced to focus on the types of financial
instruments, trading strategies, and risks associated with potential investment
opportunities.[25]Such IKTs could be used for their
informational value (rather than their raw score) to help increase investors’ awareness
about what they should know, or at least investigate, prior to participating in
a particular investment.A hedge fund,
for example, could have a stated level of preferred IKT score for a particular
investment opportunity.Investors below
that level could participate, but they and hedge fund managers would be on notice
that they might not understand the risks of the investment opportunity.IKTs could facilitate better incorporation of
risk into decision-making by clarifying the nature of knowledge that might be
desired for participation in particular investment opportunities.

Better risk education
is an important factor in enhancing risk management.Some of the lack of attention to risk that
led to the credit crisis is a consequence of incentive structures within the
financial services industry.However,
better risk education might encourage retail investors, sophisticated market
participants, and regulators to more closely question transactions and
investment opportunities, such as the Madoff Ponzi scheme, that seemingly
offered a riskless premium return.[26]

3. Interactive Disclosure

In addition to
regulatory penalty reform and greater focus on education, changes could also be
made that promote greater disclosure surrounding financial markets, financial
products, and risk.Regulated entity
disclosure requirements should be supplemented to require additional disclosure
concerning dynamic risk.Required risk
disclosure under Regulation S-K,[27]
which contains many of the specific disclosure requirements to which reporting
companies are subject, reflects a largely top-down perspective that focuses on
aggregate risks to the reporting entity, which may not adequately aggregate
risks embedded in networks of connectivity that may reach down to the level of
individual traders.[28]Mandatory disclosure about risk should be
supplemented to include more bottom-up perspectives, including discussion of
company risk management policies and training, as well as the specific ways in
which all employee compensation, not just that of senior executives, aligns
with the potential risks that employees may undertake.Such disclosure is particularly important for
all employees that directly engage in capital market trading activities.

C. Revolving Doors and Consequences for Failure

In the final analysis,
the credit crisis should provide lessons about the importance of appropriately
addressing failure.Consumers have felt
the consequences of the credit crisis.They were encouraged to invest in housing by government policies on interest
rates and home-buying incentive programs.[29]Creative industry packaging of mortgages,
some of which were "built to self-destruct,"[30]
occurred alongside what some have characterized as significant declines in loan
documentation standards and increases in subprime mortgage originations.[31]Prior to the credit crisis, a wide range of
homeowners, not just subprime borrowers, engaged in risky behavior that
essentially took a directional bet on the continued increase of housing prices.Some borrowers had insufficient incentive to
avoid high-risk mortgage loans that they might not be able to pay.[32]In the credit crisis aftermath, consumers
have been punished, in many instances far beyond the scope of any risk-taking
activities they might have undertaken.[33]Although consumers in the U.S. do have the option
of walking away from their mortgages, doing so is financially costly and likely
to negatively impact their credit.[34]

In contrast to
failures by consumers, failures by industry participants and regulators occur
in an environment of revolving doors, where failure may be rewarded with a
better position.[35]Revolving doors enable industry participants to move from current
failures to future prospects.For
example, being involved in the failure of a hedge fund has not limited future
career options in a number of high-profile cases.[36]Although some firms such as Lehman Brothers
were permitted to fail, many financial services institutions whose activities
would otherwise have led to firm failure were saved by government intervention.[37]Even though the systemic failure rationales
for such rescues may be cogent and reasoned, preventing firms from failing
poses a significant problem for the future.Institutions that cannot fail are likely to continue to take outsized
risks that generate significant private profits on the upside and large public
losses on the downside.Failures by
individual industry participants and firms may thus not be sufficiently penalized.

Although industry
failures have and should be highlighted, greater attention also needs to be
paid to government failures.Prevention
of future crises will greatly depend on the extent to which both government and
industry participants can be held accountable for failure.[38]Although greater industry expertise and
additional resources are needed at the SEC,[39]
the revolving door between the SEC and Wall Street may have contributed to SEC
regulatory failures.[40]Similarly, SEC staff supervision of the
Madoff investigation may have been more concerned about damaging future career
prospects than giving teeth to the SEC investigation.[41]Concerns about future career opportunities
may also have been a factor in the SEC failure to pursue action against Ponzi
operator Allen Stanford.The head of
Enforcement in the SEC’s Forth Worth, Texas office did not undertake an enforcement
action against Stanford—despite repeated examinations by SEC staff that
strongly suggested that Stanford was running a Ponzi scheme, later sought to
represent Stanford, and for a short period actually did so.[42]One recent empirical study suggests that biases in enforcement may
reflect systematic SEC under-enforcement against large firms.[43]This may be the product of regulatory capture,
a potential risk with any regulatory framework.Regulatory principles that emphasize transparency may be one approach
for dealing with regulatory capture.In
2007, the Senate Committees on Finance and the Judiciary conducted a joint
investigation of the SEC over "allegations of lax enforcement, improper political
influence, [and] whistleblower retaliation."[44]This investigation was a response to negative
publicity following the SEC termination of an employee involved in a hedge fund
investigation, in which assertions were made about improper political influence
in SEC enforcement investigations.[45]The joint congressional investigation also
drew attention to the revolving door between the SEC and Wall Street that some
assert improperly influences SEC investigations.[46]

Steps should be taken
to prevent and reduce the extent to which revolving doors may intensify the
likelihood of government or industry failure.A number of options might be available,[47]
including strict enforcement of bans, mandatory time lags on future employment,
or clear firewalls or recusal policies with respect to prior employment.[48]Congressman Barney Frank’s response to a
staffer who went to work for a financial services industry lobbyist may be an
approach to consider.[49]When a top staffer of the House Financial
Services Committee went to work as a lobbyist for the owner of the largest credit
default swap houses, Congressman Frank banned committee staff from talking to
the former staffer about financial regulation or financial matters until Frank no
longer chairs the Committee.[50]In the end, such steps may be one important
way to address the widespread industry and regulator shortcomings that led to
the credit crisis.

II. Conclusion

The credit crisis is a
watershed event that illustrates much about both the importance and limits of
regulation.It demonstrates, for example,
how national regulatory frameworks may be ineffective in increasingly globalized
financial markets.The credit crisis
underscores the need for regulatory reform that creates frameworks that fit the
contexts of their application.Regulation also needs to address the persistent problem of failure and
how to ensure that existing incentives do not reward failure by either
regulators or industry participants.Regulation is also increasingly a factor in global competitiveness, as
well as a mechanism that can instill confidence in financial market
integrity.Confidence is a huge factor
in the financial services industry.[51]In addition to causing significant market
volatility and instability, market crises may deleteriously impact market
confidence.In an industry where
physical assets are few and intangible assets are paramount, a failure in
confidence may also cause financial markets to freeze.A crisis of confidence can be difficult to
overcome.

Market crises often
test confidence and may even trigger regulatory reactions that toughen the
application of existing legal frameworks or lead to the adoption of new ones in
response to a particular market crisis.The current market crisis unfolded in arenas with significant existing
regulation.Existing reform legislation
fails to take sufficient account of the implications of regulatory failures
that contributed to the credit crisis.On May 20, 2010, the U.S. Senate passed the financial reform bill
sponsored by Senator Chris Dodd.[52]Although this new legislation purports to
address the underlying problems that led to the credit crisis, as has been the
case historically in the United States, it targets the causes of the last
crisis rather than achieving overarching reform of vulnerabilities and other
problems in financial market regulatory frameworks more generally.[53]More fundamental regulatory reforms are
needed to address potential future market crises.Reactions to the current crisis should thus
be initiated at the same time as an overall assessment of existing regulation
prior to the adoption of any new regulatory requirements.Existing regulatory frameworks should be
evaluated and new regulations adopted taking into account specific regulatory
principles.Further, regulatory reforms
in response to the current crisis should be shaped by acknowledgment of a
fundamental shift in the nature of trading activities and financial market
networks.Changing technology has shaped
trading activities in a broad range of entities, both regulated and unregulated.The incentives that govern traders and other
market participants in such trading contexts should be key considerations in
proposed regulatory reforms.Such
incentives can play a significant role in determining the extent to which
financial market networks embody speculative risk-taking trading activities or
reflect more cautious approaches to risk that truly incorporate private market
discipline and minimize the potential for systemic market instability, network
failure, and industry and government failure.

5. Id.; see also U.S. Gov’t Accountability Office, GAO-02-302,
SEC Operations: Increased Workload Creates Challenges 29–30 (2002),
http://www.gao.gov/new.items/d02302.pdf (noting that although federal bank
regulation is self-funded, SEC collections are deposited with the U.S. Treasury
in an account that provides for SEC appropriations and other uses and that SEC
collections significantly exceed the amount of SEC appropriations) (link).In 2003, SEC collections were projected to be
$1.3 billion, while the President’s appropriation request for the SEC was $467
million.Id.

6. Congressional Budget Office, Report on the
Troubled Asset Relief Program 2 n.6 (2010), available at http://www.cbo.gov/ftpdocs/112xx/doc11227/03-17-TARP.pdf
(noting that the authority for the Troubled Asset Relief Program (TARP) was
originally set at a maximum of $700 billion but was later reduced by about $1.3
billion) (link).

7. Id. at 1 (estimating that TARP will cost
taxpayers $109 billion and noting that Office of Management and Budget cost
estimates total $127 billion).

8. See Comm.
on Capital Mkts. Regulation, The Global Financial Crisis: A Plan for Regulatory
Reform 7-23 (2009), available at http://www.capmktsreg.org/pdfs/TGFC-CCMR_Report_(5-26-09).pdf
(detailing the impacts of the financial crisis and noting that some aspects are
difficult to quantify) (link).

13. Id. at 4.A typical fixed rate debt instrument would
have the fixed interest rate for the life of the instrument determined at the
time of issuance and would not change with interest rate fluctuations. Richard
A. Brealey, Stewart C. Myers & Franklin Allen, Principles of Corporate
Finance 398 (9th ed. 2008).In
contrast, a variable rate debt instrument would generally have the method of interest
rate calculation determined based on a variable benchmark interest rate and
credit spread at the time of issuance (e.g., LIBOR (London Interbank Offered
Rate) + 1%).Id.As a result, even though
the effective interest rate would vary over the life of the variable interest
rate debt instrument, the method of calculation and the credit spread above the
benchmark rate of interest would be established at the time of issuance.

18. U.S. Gov’t Accountability Office, GAO-09-358,
Securities and Exchange Commission: Greater Attention Needed to Enhance
Communication and Utilization of Resources in the Division of Enforcement
6-8 (2009),
http://www.securitiesdocket.com/wp-content/uploads/2009/05/gaoreportsec.pdf
(noting declining levels of SEC penalties in the period preceding the credit
crisis, with penalties becoming more like disgorgement) (link).

22. Administrative
Complaint at 25-29, In the Matter of UBS
Securities, Inc., No. 2008-0045 (Mass. Sec. Div. June 26, 2008), available at http://www.sec.state.ma.us/sct/sctubs2/ubs2_complaint.pdf
(noting lack of training and understanding about ARS by UBS financial advisors
that sold ARS) (link).

23. See James B. Stewart, Risks of a ‘Safe’ Investment Are Found Out
the Hard Way, WSJ.com, Feb. 27,
2008, http://online.WSJ.com/article/SB120406650371394765.html (link).

24. Regulation
D, 17 C.F.R. § 230.501(a) (2010), available
at http://edocket.access.gpo.gov/cfr_2009/aprqtr/pdf/17cfr230.501.pdf
(defining an accredited individual investor to include banks and savings
institutions as well as persons with an individual or joint net worth in excess
of $1 million or person with an individual income in excess of $200,000 or
joint income in excess of $300,000 in the two most recent years with a
reasonable expectation of the same level of income in the current year) (link).
The Restoring American Financial
Stability Act of 2010 Senate bill would significantly change the operation of
Regulation D and permit the SEC to disqualify certain Regulation D
offerings.See Restoring American Financial Stability Act of 2010, S. 3217,
111th Cong. § 926 (2010), available
at http://banking.senate.gov/public/_files/ChairmansMark31510AYO10306_xmlFinancialReformLegislationBill.pdf
(link).

25. See U.S.
Gov’t Accountability Office, GAO-08-200, Hedge Funds: Regulators and Market
Participants Are Taking Steps to Strengthen Market Discipline, but Continued
Attention is Needed 29 (2008), http://www.gao.gov/new.items/d08200.pdf
(noting that "[t]he ability of market discipline to control hedge funds’ risk
is limited by some investors’ inability to understand and evaluate the information
they receive . . . ") (link).

26. See Kara Scannell, SEC Had Chances for Years to Expose Madoff’s Alleged Ponzi Scheme, WSJ.com Dec. 15, 2008, http://online.WSJ.com/article/SB122928886040304911.html?mod=articleoutset-box
("The revelations are the latest blow to the reputation of an agency that has
been criticized for insufficient enforcement and the failure to better monitor
the dangerous risk-taking on Wall Street that triggered this year’s financial
crisis.") (link).

28. See id. at§ 229.305, available at
http://edocket.access.gpo.gov/cfr_2009/aprqtr/pdf/17cfr229.305.pdf ("In
preparing the foreign currency value at risk disclosures, this registrant
should report the aggregate potential loss from hypothetical changes in both
the DM/ FF exchange rate exposure and the FF/$US exchange rate exposure.") (link).

29. See Edmund L. Andrews, Greenspan Concedes Error on Regulation, NYTimes.com, Oct. 23, 2008, http://www.NYTimes.com/2008/10/24/business/economy/24panel.html
("Mr. Greenspan’s critics say that he encouraged the bubble in housing prices
by keeping interest rates too low for too long and that he failed to rein in
the explosive growth of risky and often fraudulent mortgage lending.") (link);
Jo Becker, Sheryl Gay Stolberg & Stephen Labaton, White House Philosophy Stoked Mortgage Bonfire, NYTimes.com, Dec. 20, 2008, http://www.NYTimes.com/2008/12/21/business/21admin.html
("‘This administration made decisions that allowed the free market to operate
as a barroom brawl instead of a prize fight,’ said L. William Seidman, who
advised Republican presidents and led the savings and loan bailout in the
1990s. ‘To make the market work well, you have to have a lot of rules.’") (link).

32. Martin
Feldstein, How to Help People Whose Home Values
Are Underwater, WSJ.com., Nov.
18, 2008, http://online.WSJ.com/article/SB122697004441035727.html (link). Various government policies further encouraged
consumer leveraging trends.The Bush
administration initiated a program to encourage home ownership that permitted
home purchases with no money down.Tax
policies, including the deductibility of home mortgage interest payments and
tax exemption for capital gains from home sales adopted in 1997 during the
Clinton administration, further encouraged consumers to purchase homes.See Vikas
Bajaj & David Leonhardt, Tax Break
May Have Helped Cause Housing Bubble, NYTimes.com,
Dec. 18, 2008, http://www.NYTimes.com/2008/12/19/business/19tax.html (link). The
Federal Reserve under Alan Greenspan maintained low interest rates that many
assert led to a housing bubble. Id.;
see also Joseph E. Stiglitz, Capitalist
Fools, Vanity Fair, Jan. 2009.

33. See Clyde Ashley & Krystal D. Wilson,
The Credit Crunch and the Impact on the
US Economy and Global Markets: How Damaging Will It Be? 16 Proceedings of Amer. Soc. Businesses & Behavioral Scis.
3-5 (2009), http://www.asbbs.org/files/2009/PDF/A/AshleyC2.pdf
(describing negative impact of credit crisis on consumers, including increasing
mortgage defaults and foreclosures, which has put downward pressure on housing
prices and decreasing levels of available credit) (link); Simon
Johnson, Can the Federal Reserve Protect
Consumers?, N.Y. Times Economix Blog,
Aug. 13, 2009, http://economix.blogs.NYTimes.com/2009/08/13/can-the-federal-reserve-protect-consumers/
("More broadly, the former Fed chairman Alan Greenspan famously stood by
despite being warned by his colleagues about the housing bubble and the
associated abuses of consumers. As the
housing frenzy developed in 2003 and low-income people got sucked in and—many
of them—suckered, Mr. Bernanke argued for a further lowering of interest rates
on the basis of short-run macroeconomic considerations; apparently he was
oblivious to the dangers that implied to consumer-as-borrowers.") (link).

34. Nick
Timiraos, Some Buy a New Home to Bail on
the Old, WSJ.com., June 11,
2008, http://online.WSJ.com/article/SB121314811278463077.html ("To be sure,
walking away from a mortgage, even if legal, has plenty of drawbacks: Borrowers
lose the ability to take out unsecured loans, since foreclosures can stay on a
credit report for seven years. In some
states, lenders can sue for assets, including a new house.") (link).

35. Michael Lewis & David Einhorn, The End of the Financial World as We Know It,
NYTimes. com, Jan. 3, 2009, http://www.NYTimes.com/2009/01/04/opinion/04lewiseinhorn.html
(describing the SEC as "plagued by wacky incentives" based on prospect of
future employment on Wall Street) (link).

37. Office of the Special Inspector General for the
Troubled Asset Relief Program, Quarterly Report to Congress 33-48
(2010), available at http://www.sigtarp.gov/reports/congress/2010/April2010_Quarterly_Report_to_Congress.pdf
(giving overview of TARP programs and status of firms receiving TARP funds as
of March 31. 2010) (link);
see alsoBaird Webel, Cong. Research Serv., R 40438, Ongoing Government
Assistance for American International Group (AIG) 2 (2009), available at http://www.fas.org/sgp/crs/misc/R40438.pdf
(describing the "essential failure" of AIG) (link); Office of the Special Inspector General for the
Troubled Asset Relief Program, Initial Report to the Congress 41-90
(2009), available at http://www.sigtarp.gov/reports/congress/2009/SIGTARP_Initial_Report_to_the_Congress.pdf
(listing recipients of bailout funds, which include financial services firms
such as J.P. Morgan, Citigroup, Goldman Sachs, Morgan Stanley, and Bank of
America, as well as AIG, General Motors, and Chrysler) (link);
Bryan Burrough, Bringing Down Bear
Stearns, VanityFair.com, Aug.
2008, http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808
(describing the near failure of Bear Stearns) (link).

38. Congress,
for example, bears few consequences for legislation that produces failed and
fragmented regulatory frameworks.Ironically, fear of failure at the SEC may have been a factor in the failure
to pursue the Madoff investigation, while the desire to avoid a case that was
not bullet-proof and bring a larger quantity of cases may have been a factor in
the failure to pursue an enforcement action against the Stanford Ponzi
Scheme.See Donald C. Langevoort, The
SEC and the Madoff Scandal: Three Narratives in Search of a Story
(Georgetown Law Faculty Working Paper No. 116, 2009), available at http://scholarship.law.georgetown.edu/fwps_papers/116/
(describing how sensitivity to failure influences SEC investigations) (link).

41. Lewis
& Einhorn, supra note 35
("If you work for the enforcement division of the S.E.C. you probably know in
the back of your mind, and in the front too, that if you maintain good
relations with Wall Street you might soon be paid huge sums of money to be
employed by it.").

43. See The Firing of an SEC Attorney and the
Investigation of Pequot Capital Management: Hearing Before the S. Finance and
Judiciary Comms., 110th Cong. 37 (2007), available at http://permanent.access.gpo.gov/lps86499/Leg_110_080307_SEC[1].pdf
[hereinafter Pequot Report] ("Evidence
we reviewed suggests that the reluctance to question Mack represents a much
more subtle and pervasive problem than an individual partisan political favor. SEC officials were overly deferential to Mack—not
because of his politics—but because he was an ‘industry captain’ who could hire
influential counsel to represent him.") (link).

See also Joe
Nocera, Chasing Small Fry, S.E.C. Let
Madoff Get Away, NYTimes.com,
June 27, 2009, http://www.NYTimes.com/2009/06/27/business/27nocera.html?pagewanted=1
(link);
Stavros Gadinis, The SEC and the
Financial Industry: Evidence from Enforcement Against Broker-Dealers 8 (Harvard
Law and Economics Discussion Paper No. 27, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1333717
("Instead, any bias towards big firms is systematic, and thus consistent both
with complaints about the agency’s limited resources and with concerns about
the impact of the ‘revolving doors’ between the SEC and the industry.") (link).

46. Id. at 82–87 (discussing post-SEC
employment of an Associate Director in the SEC Enforcement Decision, who joined
the law firm that had contacted the SEC concerning questions relating to a firm
client’s role in a transaction being investigated by the SEC, and focusing on
whether this employee recused himself from the investigation in a timely manner
after he began pursuing employment with the same law firm).

47. Existing
conduct and conflict of interest rules already address questions relating to
revolving doors.For example, SEC
Regulation Concerning Conduct of Members and Employees and Former Members and
Employees of the Commission Rule 8 "prohibits a former Commission employee from
appearing before the Commission in a representative capacity in a particular
matter in which he or she participated personally and substantially while an
employee of the Commission." SEC, supra
note, 42
at 10 (citing 17 C.F.R. § 200.735-8 (a)(1) (2010)).